Smartphone upgrade rates fall as market matures [Updated]

For years, if U.S. smartphone owners wanted a newer device, they had to wait until they were eligible. That’s because the cost of the phone is often subsidized through overpriced monthly voice and data plans, and carriers need to recoup the hardware cost before letting a customer upgrade.

But suddenly, that’s starting to change. First T-Mobile announced its JUMP plan that would let customers get a new smartphone as often as twice a year. And on Tuesday, AT&T unveiled its Next plan, which allows for a new handset or tablet annually. Verizon is expected to offer a similar program next month.

What’s happening here? It turns out, according to a story in today’s Wall Street Journal, that smartphone sales are starting to peak. People are upgrading to new hardware less often, and so carriers and handset makers are looking for ways to goose the market.

WSJ reporter Spencer E. Ante cites numbers from analysts at UBS AG:

The rates at which American cellphone users have traded in their devices for more advanced models have declined over the last few years, according to analysts at UBS AG. They turned negative last year, when about 68 million people upgraded their phones in the U.S., down more than 9% from a year earlier.

This is a trend that’s expected to continue. Smartphone penetration now stands at 70 percent of customers with contracts, which signals a maturing market, according to NPD. (Note that not every research firm agrees with this figure. Nielsen recently estimated smartphone penetration at 61 percent.)

In addition, customers feel less compelled to get the latest and greatest as improvements become incremental. If you’ve got a perfectly good iPhone 4S or a Samsung Galaxy S III, stepping up to the iPhone 5 or Galaxy S4 may seem unnecessary. Indeed, the current crop of phones are good enough that they may be more than adequate for several years for many mainstream buyers.

This trend tracks what’s happened to the PC business, which has been in a downturn for more than a year. PCs purchased three, four or five years ago – in some cases longer – are capable enough that they still run today’s software quite nicely. For example, I’m writing this on a 24-inch iMac I bought nearly six years ago. Even though I recently had to replace its hard drive, it’s still going strong and likely will last me at least another year. The newer, thinner iMacs are certainly sweet machines, but I don’t feel compelled to replace this one yet.

When the iPhone was introduced in 2007, it jumpstarted the smartphone category. Competition from Android caused an acceleration in power, design and feature evolution, and the switch was on from lower-end feature phones. With the smartphone market approaching saturation, those who sell them have to change tactics.

And that’s why you see conflicting moves on the part of the carriers. Both Verizon and AT&T recently increased the amount of time customers buying subsidized phones must wait until they can upgrade on the cheap. AT&T, for example, recently announced contract customers now can’t upgrade at a discounted price until the full 24 months of their service contract is up.

That’s the stick. The carrot is its Next plan, which lets you pay for the phone separately in monthly installments, and then upgrade after a year. Of course, as I wrote Tuesday, you must have a data/voice plan to qualify, and that’s at the same price that subsidized-phone buyers are paying. It’s definitely not a bargain, and Nilay Patel at The Verge went so far as to call it a ripoff.

In general, the carriers would love to get away from subsidies, but clearly they don’t want to lose the cash cow from their current service plans. T-Mobile’s downward adjustment of its voice and data pricing when it dropped contracts and subsidies was bold, but the smaller carrier needed a way to differentiate itself from the big boys.

I am not holding my breath in anticipation that AT&T and Verizon will cut their plan pricing if they can wean their customers off subsidies – unless T-Mobile is wildly successful. These are challenging times in the smartphone business, and unless there is another breakthrough in capability or design, it won’t get better anytime soon.